Why lower scrapping activity signals positive shipping momentum (Part 5)

Scrapping level and shipping rates

One indicator that analysts use to formulate supply growth projections is the number of ships retired. But while scrapping activity does limit supply growth and rates decline, it’s best suited to get an immediate to medium-term assessment of supply and demand dynamics—depending on how you slice and dice it.

This is because the rate at which companies scrap ships often reveals whether the dry bulk shipping industry is facing excess capacity. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on shipping rates and maintenance costs.

Scrapping may turn down

On November 1, the total number of ships retired since IHS Global Limited began collecting the data in 2005 rose seven vessels from a week ago, reaching 2,222 vessels. On an eight-week moving average basis, used to show a clearer trend, the number of vessels scrapped rose from 8 to 8.13 vessels. But trends in past scrapping activity (shown as the green line) may suggest scrapping activity will fall soon, which would be a short-term positive.

The late scrapping increase is negative

The late increase in scrappage could reflect some near-term weakness in the dry bulk sector. However, companies have been scrapping fewer and fewer vessels since June 2012, which is a medium- to long-term positive. As we saw earlier in construction levels and supply growth, ship capacity is expected to expand by less than 4% in the next two years. With fewer deliveries, managers won’t need to scrap as many ships.

Lower scrappage is positive

Companies often report the number of ships available to scrap as evidence of limited supply concerns, but the reality is that several ships do celebrate birthdays beyond 25. Managers are also unlikely to scrap ships just because they’re old and will often try to hold on to old vessels as long as they can find customers to use them.

So investors should see falling scrappage as a positive sign that shipping rates are rising. Besides, when shipping rates do recover, second-hand vessels actually increase in value way more than new-build prices—another key indicator.

Positive trend

If the current trend remains intact, scrapping activity should fall to the levels seen during 2009 and 2010 and in late 2014 or early 2015. As long as scrappage activity continues to fall over the medium term, it’s a positive indication that fleet utilization (supply and demand dynamics) is tightening, which is positive for shipping rates and stocks like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), and Navios Maritime Holdings Inc. (NM). The Guggenheim Shipping ETF (SEA) will also benefit.

Source:

http://marketrealist.com/2013/11/lower-scrapping-activity-signals-positive-shipping-momentum/